SOPHISTICATED FINANCE

FIU Hosts Water Issues Forum

This year's business plan competition at the Pino Entrepreneurship Center at FIU featured many environmentally oriented and cleantech business concepts. In keeping with this theme, the Center is co-hosting a discussion forum on water issues in Florida to be held Friday, August 10. The complete announcement is below, and for additional information contact Banu at bsizi001@fiu.edu.

Tags

If you use the Web to improve your productivity, blog or for social networking you are frequently usings tags. Sites such as delicious, Technorati, Clipmarks, Facebook and many others work best with tags. For example, if you found a good image or graphic that you wanted to post to your blog, save in delicious and publish in Clipmarks, you would need to enter the same tags three times (hint:Technorati tags for the blog post).

I hope somebody is coding away to produce the first "tag generator" that let's you tag multiple sites and then update all those sites. This free, new business idea is brought to you by the "Hacker Wants an Easier Life" Foundation" :)

Guidelines for Raising the A Round of Venture Capital

VCs are somewhat reluctant to provide guidelines for their investments for fear that they may scare away the next Google or Facebook. Before listing the guidelines (that I have deduced from dealing with VCs) for the first round of venture capital--the A round, let's confirm a few basic points:

1. Only send information to VCs that have a demonstrated interest in your industry or technology
2. Try to get a good introduction to the VC; avoid the 500 email blast
3. Pick potential VCs who are geographically close and then work outward; for example, California VCs typically do not do early stage Florida companies.
4. You need to demonstrate a solid understanding of your market and its potential size

Now with the assumption that you have survived the seed stage and have some customers and revenue, here are some of the key things the VCs will look for:

1. Revenues of $1 million, based on a fiscal year, trailing 12 months or run rate. Even increasing monthly revenues that will total nearly $1 million for 12 months by closing may suffice. The magical $1 million in revenue demonstrates that you have real customers. ($3 million demonstrates that you can commercialize the product (the next milestone) and $10 million demonstrates that your business can scale.)
2. No significant customer concentration. 1 customer companies or companies with one large customer do not demonstrate a customer base usually.
3. Sticky customers without a lot of churn (or at least not more churn than industry norms)
4. Accelerating revenues as opposed to lumpy sales. Every month does not have to surpass the previous month but a solid trend is important.
5. Breakeven EBITDA or a near term plan to reach that level or positive EBITDA
6. Capital efficiency in getting to this point. If you have invested more than about $5 million to build a company with $1 million in revenues you are not usually attractive (unless you are in biotech, pharmaceuticals, etc.) See this prior post on capital efficiency.

Every set of guidelines has its strengths and weaknesses. If startups keep these guidelines in mind as targets for their early development, they should be more attractive to VCs when they need to raise their A round.

Everyone has heard the stories of the VC that funded an idea presented on a napkin. I met a well known Silicon Valley VC who acknowledged that he had done one deal that way--in 20 years of investing. Don't plan on a long shot. Figure out how to get to $1 million in revenue and then go for your A round if you need capital.

Raise More Cash II

Ask The Wizard has a new post on how much money to raise in the A round (the first round from institutional sources, e.g. VCs). The basic argument is that one should be conservative in calculating the cash required for a new business because of the uncertainties of an early stage company. That, I agree with 100%.

The author then goes on to recommend raising the minimum amount of cash required rather than having a large A round. The argument presented is that if a fortuitous trade buyer comes along early, and the capital raised is small, you can sell out quickly, not have to worry about VC "blocking rights" and put a few million dollars in the founder(s) pocket. VC blocking rights, which are a standard provision, give the VC the right to block a sale of a company, regardless of the VC's shareholding percentage, in order to protect their expected return. Such rights are particularly important when the VCs are minority shareholders, as Ask The Wizard illustrates well in the post. The point to note in this argument is that the VCs will not block the sale if their return expectations are met. (Note: "argument" as used in philosophy not as in screaming and yelling)

I do not believe a startup should manage its capital raising with a quick, fortuitous exit in mind. Also, I do not believe that an "exit" has any meaningful role in company building. Yes--VCs usually want to realize their investment within ten years and they will ask "what is your exit strategy", but the focus of a founder needs to be on company building. Preferably, the focus is on building a large company (annual revenues of hundreds of millions with a correlated market value). If you want to make a quick few million become a derivatives trader. Less work, more fun.

I have worked closely with two founders that each built companies with revenues and market cap in the billions. Neither man ever talked about their net worth, selling shares to raise personal cash or exit strategies. Both men publicly listed their companies, but the reason was as a means to access greater amounts of growth capital. (One did provided the VCs an 8X return in 18 months.) Both of these founders devoted their time and energy to finding new ways to grow their companies and constantly preached about their strategy for the company. In my experience, founders who think and talk a lot about exits do not usually build large, successful businesses.

Raise More Cash I is here.

Capital Efficiency

Much has been written about Web 2.0 and the billions of dollars invested by venture capitalists. Most of these stories focus on the growth potential from viral marketing and user generated content. What deserves more attention is the capital efficiency of the business models for social networks, widgets and blogging tools. These companies have very low startup costs and very high EBITDA margins (EBITDA/sales). EBITDA margins can be as high as 50 percent of sales.

Low startup costs and high internally generated cash flow are a big part of what excites the VCs about Web 2.0. The exhibit below helps to illustrate this point. "Investment" is the new money put in by the VC. "Ownership" is the percent of the company the VC owns post money. "Multiple of Investment" is the target return the VC is seeking in year 5 (invest $2 million and the target return to the VC would be $20 million. "Sale multiple" is the number of times EBITDA to reach the exit valuation. (While the Web 2.0 companies are selling for much higher EBITDA multiples because of their higher EBITDA margins, 8.0 is a standard multiple used by many funds to estimate exit valuations.) "EBITDA margin" is at the time of exit. "Sales required year 5" is the annual revenue at the time of exit in order to generate a 10x return for the VC based on the other assumptions. (There is no consideration of liquidation preferences in this model.)

What the exhibit demonstrates very clearly is that when your EBITDA margin is over 20% you do not have to build a very large company to generate a 10X return for the VC. Given that the timing of most VC exits occurs when company revenues are less than $100 million, we start to see why VCs are so interested in Web 2.0. The capital efficiency of Web 2.0 companies provides a greater likelihood of generating the target 10x return for the VC.

Some lessons to be learned from Web 2.0 companies that apply to any startup include:

1. Be very suspect of adding fixed costs because they tend to lower EBITDA margins
2. Look for low cost sales and marketing techniques (e.g. viral marketing)
3. Outsource as many functions as possible (e.g. the Quickbooks on line version)
4. The higher the EBITDA margin, typically the higher the exit multiple
5. For every $2 million in additional new investment, you need to increase annual sales by $60 million (if the EBITDA margin is only 10 percent) to generate a 10X return for the investor by year 5.

If anybody would like a copy of the spreadsheet, send me an email. For those not familiar with EBITDA, it is defined as net income + taxes + depreciation + amortization + interest expense.

Presentation: Art or Science

I make frequent presentations, which fall into four broad categories:

1. classroom presentations for my course in entrepreneurship
2. workshops at the Pino Entrepreneurship Center at FIU
3. status reports to clients on findings and recommendations
4. client presentations to investors

My presentations skills have been helped greatly by three blogs which all have a different focus-Extreme Presentation,  Create Your Communications Experience, and Presentation Zen. These blogs are particularly helpful because their advice is both logical and practical and the examples cited expand your understanding of the advice. The most important lessons from these blogs are:

1. Show your real self to the audience so that listeners can relate to you
2. Use stories and jokes to engage the audience and illustrate your points
3. Simple visual slides are more effective than lots of prose
4. Don't hide behind a lectern and be active and animated when you present
5. Understand what the listeners want from the presentation--not what you feel compelled to discuss
6. Don't use music and fancy slide transitions--they distract from the message and annoy listeners

Follow these simple rules and you may avoid the dreaded "death by Powerpoint".

So, now--is presentation art or science? The answer to this question actually does not matter. If you follow the advice above and in the blogs I listed, you can become a very good presenter, which is all most of us need to do. If you plan to be a televangelist or sports celebrity, hire a good presentation coach and still study presentation.

Business Plans

People always comment that I write short business plans. Yes--but they raise capital.

Most of the business plans I see are very repetitive, do not make the investment thesis clear and omit key information. Part of the problem is that most of the books and computer software available usually misses the point. Sequoia Capital, one of the most prestigious venture capital firms, has a great  description of what they want to see from entrepreneurs and their checklist is only  one page.

When I write business plans I follow this outline:

• Executive Summary

1. Overview
2. Summary Financial Highlights
3. Sources and Uses

• Company

1. History, Background and Operations
2. Market
3. Technology
4. Management
5. Forecasted Financial Information

Contrary to most people, I write the Executive Summary (ES) first. I do this in order to be sure that I understand the investment thesis and the remainder of the plan becomes support for this idea. The investment thesis is the hook that will get the investor to read the rest of the plan. The investment thesis is the compelling idea to demonstrate why this company warrants investment. After the first sentence in the ES describes the company and where it is located, I state the investment thesis in the second sentence. The second paragraph in the ES describes the problem that the company is solving and the key parts of their solution. The third part of the ES is a description of the market and a brief description of the competitive landscape. (Their is always competition).I focus on giving the reader a clear idea of the target customer. Next I highlight  the relevant experience of key  senior managers and conclude with a description of  the money invested to date in the company, noteworthy shareholdings (such as management) and how much new capital is required. Total  for this section is about  400 words  unless I have added an extra paragraph to describe the technology in more detail.

Summary Financial Highlights show year to date results, trailing twelve month results and forecasted yearly results for 3-5 years. The highlights include revenue, gross margin, EBITDA, working capital, equity and new capital. I also include the key driver for revenue in units (subscribers, stores, widgets sold, etc).

The Sources and Uses section is where I explain how the money raised will be used. A schedule with limited prose usually suffices.

In the Company section I begin by stating when the company was founded and provide a short history of the company. The focus is on milestones and achievements. Except for recognition like Nobel prizes, I don't mention awards from the Kumquat Chamber of Commerce or other prestigious but unkown organizations. A description of the product with pictures or screen shots then follows. I then proceed to describe the customer base and how the company reaches their customers. Focus here is on sales and distribution. Sales people, click through rates, and subscriber acquisition cost are all examples of the detail presented. Geographic markets are outlined, if applicable. (The seventeen pages of proposed TV ads with scripts are omitted from the plan here.)

Next we move on to describe the market, providing as much detail as possible on what we think is the size, how customers make their buying decision (factors), the sales cycle (time to close) and what will accelerate sales growth (viral marketing, key accounts, distribution agreements,etc.) The existing customer base is described in sufficient detail to demonstrate that we understand well our existing customers. Any significant customer concentration is disclosed. In a low tech business I then describe the competition and how their products compare with the company. A matrix or schedule is often the most effective way to present this information.

In the technology section we describe the innovation in sufficient detail for it to be appreciated by a knowledgeable investor. I usually start with the science, if applicable, and then move to the technology. In a high tech company I then usually include a description of the competition, their technology and a detailed comparison of competing products. (If I was presenting a new cooking grill I would start the comparison with "campfires" :).)

The management section is the standard version, but I always include college degrees even if the CEO/Founder does not have a degree.

The forecasted financials section usually makes reference to a detailed model and does not include a re-print of all the model information. (I build self-explanatory models and attach them with the business plan.)

Each of the first four sections in the Company chapter is 2-3 pages including exhibits. More than this amount of information is usually repetitive, boring or confusing.

Sections that I see frequently but almost always exclude are:

1. Bios on the Board of Directors (usually nobody will give the investor any extra confidence in the company
2. Advertising materials (investors are typically scared off by high levels of advertising spend and I discourage clients from proposing advertising driven growth models)
3. Detailed market research results (a summary in the Market section usually suffices)
4. Elaborate product development schedules that span 5-7 years (investors are interested in 1-2 years)
5. Any mention of the form of incorporation or any previous changes to the current structure (the investor will stipulate the form of incorporation they need).

The above is an overview of how I write a business plan. If you would like to see an example, send me an email. A previous related post on strategy is here.

Forbes Launches Widgets

Will Price posted that Forbes.com is launching eight widgets featuring their content and advertising with sponsorship from Visa. The widget technology is from Widgetbox. The widgets can be seen here.

I promise to only blog on branded widgets once a week.... but the sponsorship from Visa is an interesting development. Visa obviously sees widgets as a new form of advertising that they need to understand. Wonder how many advertisers and sponsors can fit on one widget? Maybe next we'll see widgets show up in the Google "sponsored" links of a search results page.

Presentation Lessons for Entrepreneurs

Guy Kawasaki writes a great blog with very practical advice on presenting to VCs and how to make better presentations of any kind (along with some other interesting themes). Today's post "The Top Ten Lies of Entrepreneurs" is a must read. I have counseled clients not to say all of these "lies" and I think I'll make this post a hand out for new clients seeking venture capital. Most of the list also applies to companies seeking private equity or hedge fund financing.

The one "lie" I take some exception to is number 2-- "(Big name research firm) says market will be $50 billion in 2010". In half the cases where VCs have gotten seriously interested in due diligence, they have asked my clients what research reports they have that could be shared with them. Typically they are trying to better understand the market size (perhaps where the client has not yet convinced them of the market potential).

Maybe it's just east coast VCs that can read see some value in research reports.

Bad Accounting

A young friend who has worked as a financial analyst for two years asked me yesterday "why is accounting so bad?" To clarify his question, he wanted to know why accounting was not done properly. I answered:

1. Many of the people doing accounting and bookkeeping do not know GAAP (Generally Accepted Accounting Principles) and have never studied it
2. It's hard to stand up to an owner or CEO when you are the sole wage earner for your family
3. Non-GAAP accounting frequently lends itself to greater availability under borrowing base formulas with secured lenders

When I have had to hire controllers or senior accountants I always insist on candidates that have worked for large CPA firms. I also prefer that they have worked in industry after their public accounting so that they are familiar with bookkeepers and junior accounting staff that have not studied GAAP.

OLPC-Great Technology, Great Cause

Today I met with Richard Bernstein to catch up. Rich is a partner at Greenberg Traurig, the large, Miami-based law firm, where he is a senior member of the corporate securities and transactions practice. As soon as we got our coffee, Rich began talking about a new client. Rich is serving as counsel in Central and South America for OLPC. (Rich and I share a deep interest in technology and international business and he has a great sense of humor.)

OLPC (One Laptop per Child) is Nicholas Negroponte's project to provide a $100 computer to every child in the third world. Negroponte is a Professor at MIT, the co-founder of the MIT Media Laboratory and wrote some fascinating articles in the 1990s for Wired about the future of the Internet, media and technology.

Rich detailed the technical specs for the laptop (open source software, AMD chip, 1G of flash memory, camera, etc.) and pointed out four distinctive features:

1. a patented screen that works in direct sunlight (because many third world schools are outside)
2. a 10 hour battery that can be recharged up to 1000 times (compared to 300-500 for a normal laptop battery) and many other "green" features
3. wireless communication between nearby OLPC laptops without the need for routers
4. mesh network technology which enables all the laptops in an area (think classroom) to have Internet access if only one computer has access

He also showed me his working model of the OLPC. A picture is at the end of the post (courtesy of www.techfresh.net). Much has been written about the OLPC, but what impressed me was the range of functionality in such a small form factor.  If I loaded Open Office, a Linux-based Microsoft Office competitor, on the OLPC I would have the complete functionality of my current Dell Machine at approximately one fifth the weight (and the battery would last about four times longer.)

I think that smaller and smaller, light laptops with long life batteries is the future direction of PCs. I think that the OLPC could now be the standard of comparison for "ultralight" laptops. Maybe this is why Dell and Intel have been so anti-OLPC. 300 million third world children having their first computer experience with an OLPC (running an AMD chip) might also be a concern :).

Now if the cell phone served as a projector for the laptop, I might not need a screen. If the PC was embedded in the cell phone, then I might only need a keyboard and .......maybe that's why Apple launched the iPhone!

Where is the Internet Going

It's not surprising that I am not the only one wondering about the future direction of the web. Nick O'Neill at Webpreneur posted here on his thoughts for the future of the web. He forsees a web of widgets and social networks, and the only competitive advantage a network will have is its user base. 

Market segmentation (user base) alone is rarely a sustainable competitive advantage. The only way a user base is a sustainable advantage is if the host or the users provide some form of accreditation. For example, almost every internist in the U.S. is a member of the American College of Physicians because the ACP grants "Fellow" status, a distinction which acknowledges the advanced training of the doctor. LinkedIn, the business networking site, appears to be following the accreditation strategy. If you answer questions on LinkedIn and the person posing the question rates it the best answer, you accumulate "expert" points in the subject area.  As soon as LinkedIn adds an "experts" tab to the website, blogs about their experts or features experts on the home page, they will have combined market segmentation with accreditation. The "expert" users will be reluctant to switch to another networking site and people will join the network to gain access to the experts.

I think a part of the future direction of the web is shown in two sites--Lijit and Widgetbox. Lijit organizes all my web content in one place and makes it searchable on leading web content sites such as delicious, LinkedIn, My Space and my blog(s). Now that Facebook has opened its platform I am sure that Lijit will soon be able to access that site also. My content on Lijit is shown below.

With each of us posting more and more content  on the web , finding where  you put content is becoming increasingly challenging and important. Lijit simplifies that task. Lijit also organizes my public "persona" so prospects, clients or employers can gather a much more in-depth understanding of me. Running a professional services business, I see a great value providing as much information to prospects as possible. With the web increasingly being driven by user generated content, organizing an individual's content will become increasingly desirable. (Now if we could get LinkedIn to put Lijit search widgets on each network member's profile that would be really convenient and increase the value of  LinkedIn.)

Putting Lijit on LinkedIn brings me to my next  point about the future of the web. Facilitating connectivity in a user friendly, easy way is going to be a must for every network and web service.  Widgetbox understands this idea and offers a one step process to embed a widget into Typepad and Blogger (blogging services), Facebook, My Space, Net Vibes, Page Flakes, Google and several other sites.  Two clicks and a widget can be embedded into any of these sites. (Lijit's interface is equally easy.) While everybody wants an easy interface, with the proliferation of networking sites and widgets users are increasingly going to choose based on ease of use (and design). In a future post I'll talk about design and some additional ideas on the future of the internet.

 
Widgetbox

Is the Internet Following the Retail Industry

In the early 1980s I visited Target headquarters in Minneapolis. They had just installed their first POS (point of sale) equipment with the expectation that it would improve cashier productivity. What they found was that the customer data was much more beneficial than the negligible improvement in cashier performance. By the 1990s Wal-Mart had advanced the use of POS data to the point where they could tell you the number of red ladies shoes, brand x, size 9 sold this saturday and the same saturday last year (and the weather on each day). What prompted Wal-Mart to develop their POS data to such a degree of completeness?

The answer lies in part in the change that took place in retailing in the U.S. in the 1980s. In the 1980s retailing changed from a push to a pull model. During the "push" period retailers put out merchandise based on what they could source. When the model changed, customers had the power and "pulled" from the store what they wanted. What caused this shift in power to the consumer was the proliferation of retail concepts and better international sourcing methods. More segmented store choices with wider and deeper choices of merchandise gave consumers the power to choose or "pull".

We are seeing the same shift in power today on the Internet through Web 2.0--the change from a "push" to a "pull" model. John Hagel, amongst others, makes this point in a post here where he discusses several trends transforming the web. In the early days of the Internet everybody was ecstatic just to find a website with accurate information on a topic that interested them. This was the "push" period where users had fewer choices and the websites had the power to determine the information. Today the web has been transformed into a "pull" model where users not only pull what they want  but also are able to self-organize the information.  Social networking (delicious, Facebook, Ning) and widgets (Lijit, Widgetbox, etc.) are just two examples that demonstrate these changes.

All consumer business models change from "push" to "pull" when consumer choices increase dramatically. The rapid pace of technological innovation, the low barriers to entry to offer new web-based services and the ability of consumers to organize their own information will make web 2.0 an unprecedented change from "push" to "pull".

The change to a "pull" model in retailing lead to the development of supply chain management and "just in time" inventory, both far reaching changes in business methods that affected a wide range of industries. The change to a "pull" model for the consumer Internet will have far reaching effects that will also extend to business processes and methods. In an upcoming post I'll write about the effects on business that I expect.

Small Company Accounting

A friend told me a story that reminds me of a problem I see frequently. My friend runs a small business with one major supplier providing many of the parts and tools. The supplier is a privately-held company with several million in annual sales. Each month the supplier renders an invoice to my friend's company for that month's purchases. The invoice is computer generated and details each purchase for the month and the cost. At the bottom of the invoice is a hand written amount for the total discount for that month's invoice and a handwritten "total payable".

My friend explained to the supplier that a total discount prevents him from determining the real price per item, and thus he can not compare prices with competing suppliers. The supplier explained that the accounting department can not produce item level cost net of discount. One can only wonder how many sales are lost each month where this supplier is the low cost provider but the customers do not know it.

The accounting department is run by a relative of the owner in order to reduce the risk of employee theft and herein lies the problem. When you hire relatives perhaps you reduce the risk of theft, but it makes it much harder to make improvements to systems and procedures when you have to worry about embarrassing a family member (who can not make the changes or does not understand the new application or system). Also, if the relative is incompetent it is much more difficult to replace them. Private equity funds and venture capitalists strongly discourage or prohibit hiring family members for exactly these reasons.

A better approach is to put in the appropriate controls. For example, if your concern is employee theft and you are worried about "fake" suppliers (a common way to steal money), put in a policy that every new supplier has to be approved by the owner and every month get a report that lists every account payable paid with check number and a list of every check written that month. Every check written that does not match an approved supplier is then scrutinized. If you are worried about the check payee being changed after it is written then use cancelled checks for the month rather than checks written.

Successful companies rely on controls rather than family members.

Thoughts on Blogging in the Early Days

I have been blogging for about a month and the experience has been better than expected.

1. Two clients have decided to start blogs as a result of seeing my blog. They plan to use the blog as a complement to their existing strategy for new business development. I also pointed out that it may be helpful to their future capital raising activities because it will help to document for potential investors how they think about their business and their approach to customers.
2. I was invited out to lunch today by one of the top marketing directors in South Florida. She wanted to discuss how her professional services firm could use blogs as a part of their marketing and customer acquisition strategy. Of course I brought up the idea of branded widgets (first posted here) and also talked about the idea of putting chat on the website so visitors could talk to a firm representative immediately. I also suggested to her the delicious link in the sidebar on the right of this blog. It gives you access to all the pages on the web that I have bookmarked and under "blog" there are some really helpful websites and blog posts on blogging. (I researched blogging for about a year before I started.)
3. The response rate to email notices about the blog is 5% of recipients are becoming subscribers. Given that the sample size is statistically significant, I am surprised that the response rate was not closer to direct marketing at about 2%.
4. I added a search widget to the sidebar and all my content on the web (this blog, my delicious bookmarks and my LinkedIn profile and "expert" answers on LinkedIn can be searched). The widget is provided by Lijit and I founded it through a post on Feld Thoughts.  When I contacted Lijit with a technical problem I got a response back in less than five minutes, which really impressed me.
5. Automatically pinging Technorati, the blog search engine, does not work very well  so I manually ping Technorati. From the FAQ  site at Technorati it looks like alot of people have the same problem. I have found that the Technorati search engine works best on proper names, so it is easy to find my post on Banyan Mezzanine but more difficult to find posts without proper names. (Maybe I should put the word "Beyonce" in every post :).

My goal for the blog is to get 1000 subscribers within a year. Now if I could just get every subscriber to this blog to tell ten of their friends about the blog and they told ten friends.........and the 5% sign up rate continues--well you know the rest.

Raise More Cash

Don Dodge writes an excellent blog on technology, The Next Big Thing , but a recent post talks about how much money early stage companies should raise from investors. He references a recent post by Marc Andreessen on the same subject.

Both writers basically make the same point—raise more rather than less money. They also make three other good points:

1. Calculate your capital need and then add on a healthy amount for contingencies and unforeseen events that negatively impact your business, e.g. 9/11
2. Determine the amount of capital needed in order to get to the next major company milestone (product launch, business scaling etc.); don’t risk raising capital before reaching the next milestone
3. Raising capital is very time consuming and a major management distraction

Over 50% of new businesses fail in the first five years and 99% of those run out of money. Many early-stage companies that I see have founders who worry more about equity dilution than raising the capital. These founders rarely raise the needed capital, raise too little money or spend all their time capital raising at the expense of business development. As Don and Marc suggest, don’t worry about dilution. Grab as much cash as you can and run………..the company.

After you raise the capital you may want to read this recent post in VC Adventure on cash management and burn rates.

Rants on Excel Models

I have just spent the last three days re-building a very detailed client model. (Yes-I know that’s what I get paid to do.) When I first started modeling in the 1980s, people were amazed just to receive a spreadsheet. In the 1990s you had to talk people through a spreadsheet for them to understand it. Today the common expectation is that a spreadsheet or model is self-explanatory. Today, if your model is not self-explanatory, it reflects badly on the company (and the preparer).

My client’s model was not self-explanatory for several reasons:

1. There was no logic to the organization of the detail. Revenue detail was not all grouped together. For example, VAT (foreign companies have “value added tax”) calculations were mixed in with revenue and cost of sales detail even though they only had a balance sheet effect.

2. There was no balance sheet-- only a P&L and cash flow statement. This omission of the balance sheet happens frequently with models I get that are prepared by Europeans. I must assume that debt leverage (by any measure) and working capital are not concepts used frequently in Europe. (It can not be the case but their models don't make it easy to calculate!!)

3. There were color coded cells to indicate a change in an assumption instead of using date-based or period-based “if” statements. Takes quite awhile to determine why changing the assumption has no effect on the model because the timing of the assumption is hard coded. (Hint: whenever you see colored cells used anywhere in a spreadsheet except for title rows, you can safely assume that the model is not self-explanatory.)

A few tips on building better spreadsheets and models:

1. Build the spreadsheet as a stand alone document that does not need explanatory comments (or other spreadsheets that were not attached)

2. Group detail logically together. Put all the revenue detail in one section or tab. Then do the same thing for cost of sales. To improve understanding, calculate gross margins by product line or line of business. In models with multiple products, provide grand totals for revenue, cost of sales and gross margin. Going to a revenue cell on the summary P&L and finding links to 10 cells does not aid comprehension. (Hint: on the summary P&L link back to a grand total.)

3. Learn to use VLOOKUP, HLOOKUP and “name” cells instead of using "links". It makes makes it much easier to understand the model (and provides a smaller model size which passes through spam filters more easily).

4. Delete cells with values that are never used in the model. Maybe you were going to use that assumption and then changed your mind. That’s OK, but delete those cells before you send out the model. If you re-use the model, put in an on-off switch (Hint: multiply by 0 or 1) for assumptions you use but not for all cases.

5. Do not hard code numbers unless they are assumptions. Every number should be a formula or linked to an assumption. Sensitivity analysis and "what if" analysis don't work well when there are hard coded numbers outside of the assumptions.

Enough ranting. A good site for improving Excel skills is here courtesy of the Fuqua School of Business at Duke University.

Every Day Is Flag Day

With the 4th of July celebrations beginning, many of us will put up our American flags to show our patriotism. With so many men and women in harms way in Iraq and Afghanistan, fly your flag every day as a sign of respect for the people protecting our freedom and maintaining our security.

For those of you planning to do a little boating during the holiday, make sure to check that your flares are not past the expiration date. Also, check that your boat fire extinguishers are still reading in the green. Carry a life jacket for every person on the boat, make sure that children wear their life jackets when underway, leave the beer and wine for after you tie up safely back at the dock and be safe.

Have a happy 4th!

Branded Widgets Coming

Widgets are snippets of html code that can be embedded in a web page to perform a specific function. In the sidebar on the right of this post my LinkedIn Profile and the Feedburner "Subscribe Using a Feed Reader" are examples of widgets.

Alex Iskold has a very interesting post at Read/Write Web about the Random House widget. Random House describes the widget:

"The widget is a lightweight internet application that can be easily embedded into a Web page. In its small version, at 195 x 335 pixels, it fits snugly into any website and delivers interactive book previews by allowing a user to page forward and back through the book or search for keywords in the actual text content of the book - without ever leaving the Web page. With one click to its main screen, the small version expands to the large version in its own full-size pop-up window (600 x 700 pixels) delivering high-quality, readable preview pages, text search and a thumbnail page navigator. The large version can also be embedded in a Web page, if you'd like to feature the book front and center."  The widget also works for  audio products from  Random House.

While some of this functionality is available at Amazon.com and Google.com, Random House can now make this functionality available to anyone referencing a Random House title on a web page (and the widget also lets you purchase the book). Some sample widgets can be found here (near the bottom of the page). As Alex points out, this widget strengthens the Random House brand and makes it easy to showcase Random House products. Can a Ford or Citibank widget be far behind?

Another interesting use of widgets is ContentLink which is used on posts at LifeHack.org. If you go to this post and scroll down to the title

Am I Crazy Here?

This is a technology that accounts for a lot of what we might want in collaboration management, hosted on hordes of servers we don’t have to touch, at the cost of free,

When you scroll over the words in blue an ad from ContentLink appears. (Because I did not embed the html code for these words in this post you need to go to the actual post to see the Contentlink ads.) The ContentLink widget provides an easy way to link your brand to a particular word or phrase.

I have just mentioned two examples of widgets, but hundreds of programmers are developing widgets to use for advertising and branding. I think that soon most major companies will launch widget strategies. Eventually we will have the "Merrill Lynch Finance Dictionary" widget. Instead of having to define every finance term I use in this blog, I will be able to insert a Merrill widget that you can scroll over to find the meaning of a term. Or, maybe every time you scroll over a company name in Yahoo Finance a Merrill widget will pop up and offer to let you buy the stock at the current offer price.

As you enjoy your 4th of July holiday, I think somebody out there is coding widgets for the Fortune 500.  Your company needs to think sooner rather than later about a strategy for widgets. Otherwise, the Miami real estate widget will be branding a company from North Carolina.